Solution manual for financial management principles and applications 12th edition titman keown

As noted in the text, firms with taxable income greater than $18.33M, the top of the 7th bracket, are indifferent between the progressive scheme and a flat rate of 35%.. As noted in the

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Solutions Manual for Financial Management Principles and Applications 12th Edition by Titman

(As noted in the text, firms with taxable income greater than $18.33M, the top of the 7th bracket,

are indifferent between the progressive scheme and a flat rate of 35%.)

Understanding Financial Statements,

Taxes, and Cash Flows

3-1 To find the net income, we must subtract all relevant expenses from revenues: cost of goods sold, operating expenses, interest, and taxes Following the template from Checkpoint 3.1, we find the following for Sandifer Manufacturing Company:

notes

Operating Expenses

Other Operating Expenses ($300,000) Total Operating Expenses ($450,000) given

Income Taxes (@35%) ($236,250) =($675,000)*(.35)

Sandifer was able to generate $438,750 in net income from its sales of $4.5M The $438,750 is now available to pay out to shareholders (dividends), and/or to reinvest in the business (retained

earnings)

3-2 We just learned (in Problem 3-1) that Sandifer has $438,750 to allocate to dividends and reinvestment

If it chooses to reinvest $50,000, then it will have ($438,750  $50,000)  $388,750 to pay out as dividends (a [$388,750/$438,750]  88.6% payout ratio)

3-3 Marifield Steel Fabrication earned net income of $500,000, then paid out a dividend of $300,000 This left ($500,000  $300,000)  $200,000 to be retained by the firm to finance growth 







63

(As noted in the text, firms with taxable income greater than $18.33M, the top of the 7th bracket, are indifferent between the progressive scheme and a flat rate of 35%.)

3-4 Barrington Enterprises earned $4M in taxable income Using the corporate tax rates given in

Section 3.3 of the chapter, we find the following:

bracket

(marginal) taxable income

cumulative income taxed

marginal tax rate tax liability

cumulative tax liability

average tax rate

#5 $3,665,000 $4,000,000 34% $1,246,100 $1,360,000 34.00%

Barrington’s total tax liability is $1,360,000, for an average tax rate of ($1,360,000/$4,000,000)  34% The chart above is very close to that in Section 3.3 However, we will explain the entries, using the calculations for bracket #3 (highlighted in the chart) as an example:

Bracket #3 is shown in the text to apply to taxable income between $75,001 through $100,000

Thus, the bracket applies to $25,000, which is what we have entered in the “(marginal) taxable

income” column The “cumulative income taxed” column shows $100,000, meaning that when

we have moved through this third bracket, we will have taxed our first $100,000 of taxable income Since we move all the way through the third bracket, we generate ($25,000 taxable income in

bracket)  (34% marginal tax rate)  $8500 in tax liability from that bracket Added to the tax we owed for the first two brackets, this implies a total liability so far of ($13,750  $8500)  $22,250 This tax liability is a weighted average of the rates whose brackets we’ve passed through: 15%,

25%, and 34% This average equals ($22,250 tax liability so far)/($100,000 taxed so far)  22.25%,

a value between 15% and 34%

Note that the final average tax rate for the firm is 34% Our average tax rate equals our marginal rate, even though our first dollars were taxed at 15% and 25%! What’s going on?

The chart below shows how the fourth bracket’s 5% surcharge (to 39%) takes away the benefits of the first two brackets Column D shows how each bracket’s taxable income increment would be

taxed, if exposed to a flat rate of 34% Column E then shows the difference between this hypothetical flat 34% tax and the actual, progressive rates The first two brackets save the company $11,750

relative to the flat 34% However, this is exactly the amount recouped by the 5% surcharge as the company moves all the way though the fourth bracket Companies that have more than $335,000 in taxable income, but less than $10M, are indifferent between the actual progressive system and a flat rate of 34%

A (marginal) cumulative

B marginal

C = A*B

cumulative average

D = A*(34% ) tax liability

E = D - C

$ saved from bracket taxable income income taxed tax rate tax liability tax liability tax rate at 34% actual tax rates

#1 $50,000 $50,000 $0 $7,500 $7,500 $0 $17,000 $9,500

#2 $25,000 $75,000 25% $6,250 $13,750 18.33% $8,500 $2,250

#3 $25,000 $100,000 34% $8,500 $22,250 22.25% $8,500 $0

#4 $235,000 $335,000 39% $91,650 $113,900 34.00% $79,900 ($11,750)

#5 $3,665,000 $4,000,000 34% $1,246,100 $1,360,000 34.00% $1,246,100 $0

SUM = $0

3-5 Sanderson, Inc.’s situation before the dividends is:

notes

Operating Expenses

However, before we can determine the firm’s tax liability, we must consider the tax due on its dividends received The firm received $50,000 from a company in which it owned less than 20% Because of the dividends-received deduction, Sanderson only needs to pay taxes on (1  0.70)  30%

of these dividends This will add (30%)  ($50,000)  $15,000 to the firm’s taxable income (Dividends paid to the firm’s own shareholders are made after taxes are paid They therefore will not affect the firm’s tax liability.)

Thus, we have:

Dividends Received, after 70% Dividends Received Deduction $15,000

Total Taxable Income $365,000

(marginal) cumulative marginal cumulative average bracket taxable income income taxed tax rate tax liability tax liability tax rate

Sanderson has $365,000 in taxable income, so it will end up in the 5th tax bracket Thus, as we saw

in Problem 3-4, this means that Sanderson’s average tax rate equals its marginal rate of 34%

3-6 The statement below outlines the situation of the Robbins Corporation:

notes

Operating Expenses

Dividends Received, after 75% Dividends Received Deduction $10,000

Total Taxable Income $60,000

Because Robbins owns between 20% and 79% of a firm’s shares, the dividend it receives from that firm are subject to a 75% dividends received deduction Thus, Robbins is only taxed on

(100%  75%)  25% of its dividends received, or (25%)  ($40,000)  $10,000

Adding Robbins’ $10,000 in taxable dividends to its $50,000 in taxable income from operations gives the firm a total of $60,000 in taxable income We can now compute its tax liability as:

(marginal) cumulative marginal cumulative average bracket taxable income income taxed tax rate tax liability tax liability tax rate

Robbins finishes in the middle of the second bracket, so its marginal tax rate (the rate on its next dollar of income, which will still be in the second bracket) is 25% Its average tax rate is the weighted average of the $50,000 taxed in the first bracket at 15%, and the ($60,000  $50,000)  $10,000 taxed at 25% in the second bracket: ($50,000/$60,000)  (15%)  ($10,000/$60,000)  (25%) 

(0.8333)  (15%)  (0.1667)  (25%)  16.67%

As for additional action: Robbins made $1M in sales, but generated only ($50,000  $10,000 tax liability)  $40,000 in after-tax (net) income (ignoring the dividends it received) It may want to search for operating efficiencies to improve its profit margins Its interest expenses, in particular, seem high

Note that we did not consider Robbins’ dividend payments to its own stockholders here, since those payments are made after taxes are paid

3-7 For J.P Hulett, we have the following statement calculating taxable income:

notes

Operating Expenses

Other Operating Expenses ($500,000) given Total Operating Expenses ($850,000)

Dividends Received, after 100% Dividends Reveived Deduction $0

Total Taxable Income $150,000

Since Hulett owns more than 80% of the shares of the firm from which it received dividends, none

of the dividends are taxable to Hulett, and we can ignore them

Given Hulett’s taxable income of $150,000, we can find its tax liability as follows:

(marginal) cumulative marginal cumulative average bracket taxable income income taxed tax rate tax liability tax liability tax rate

Hulett’s taxable income of $150,000 takes it up to the fourth bracket, where its marginal tax rate (tax on next dollar of income) is 39% Its average tax rate is a weighted average of the tax rates from the first through fourth bracket: 15%, 25%, 34%, and 39% For Hulett, this average is ($41,750/$150,000)  27.83% (If Hulett had made it all the way through the fourth bracket, its average tax rate would have been 34%, as we discussed in Problem 3-4.)

3-8 The statement below shows how we can compute the taxable income for G.R Edwin, Inc.:

notes given

$300,000 

Edwin therefore has taxable income of $370,000 Using the corporate tax tables from the chapter,

we can therefore determine the tax liability as:

(marginal) cumulative marginal cumulative average bracket taxable income income taxed tax rate tax liability tax liability tax rate

Since the firm’s taxable income moved it beyond the fourth bracket and into the fifth, Edwin’s average tax rate is 34% ($125,800 tax liability/$370,000 taxable income), as is its marginal tax rate Remember that the fourth bracket has a surcharge that gradually takes away the benefits of initially moving through the 1st (15%) and 2nd (25%) brackets Moving all the way through the fourth bracket, as Edwin did, means that all of those low-rate benefits are taken away, and the firm is left

as if it had paid a flat rate of 34% from the beginning

3-9 Meyer Inc has taxable income of $300,000, which is in the fourth tax bracket Since Meyer won’t move all the way through this bracket (its upper limit is $335,000, higher than Meyer’s EBT), its marginal tax rate will be the 4th bracket’s rate, 39% Also, since Meyer will not have moved all the way through the 4th bracket, it will not have all of the benefits of the low-rate 1st and 2nd brackets taken away; its average tax rate will therefore be less than 34% We can find its tax liability and average tax rate as follows:

(marginal) cumulative marginal cumulative average bracket taxable income income taxed tax rate tax liability tax liability tax rate

EBT: given

Meyer pays a total of $100,250 in taxes, on a taxable income of $300,000 Its average tax rate is therefore  $100,250 

33.42%



3-10 Boisjoly Productions has $19M of taxable income This puts the firm into the very highest tax

bracket, the eighth, in which the marginal tax rate is 35% In earlier problems (e.g., 3-8), we saw that firms whose taxable income fell into the 5th bracket had their low-rate brackets’ benefits taken away, leaving them with a flat 34% tax rate Firms like Boisjoly that make it all the way into the 8th bracket have a similar but more severe situation: They have all of their low-rate benefits taken away, leaving them with a flat 35% rate

taxable income =

A (marginal)

B cumulative

C marginal

cumulative

F = E/B average

#5 $9,665,000 $10,000,000 34% $3,286,100 $3,400,000 34.00%

#6 $5,000,000 $15,000,000 35% $1,750,000 $5,150,000 34.33%

#7 $3,333,333 $18,333,333 38% $1,266,667 $6,416,667 35.00%

How does this happen? We can track the benefits from the lower-rate brackets and the costs of the higher-rate brackets as shown below:

A (marginal) cumulative

B marginal

C = A*B

cumulative average

D = A*(34% ) tax liability

E = D - C

$ saved from cumulative bracket taxable income income taxed tax rate tax liability tax liability tax rate at 35% actual tax rates savings

#1 $50,000 $50,000 15% $7,500 $7,500 $0 $17,500 $10,000 $10,000

#2 $25,000 $75,000 25% $6,250 $13,750 18.33% $8,750 $2,500 $12,500

#3 $25,000 $100,000 34% $8,500 $22,250 22.25% $8,750 $250 $12,750

#4 $235,000 $335,000 39% $91,650 $113,900 34.00% $82,250 ($9,400) $3,350

#5 $9,665,000 $10,000,000 34% $3,286,100 $3,400,000 34.00% $3,382,750 $96,650 $100,000

#6 $5,000,000 $15,000,000 35% $1,750,000 $5,150,000 34.33% $1,750,000 $0 $100,000

#7 $3,333,333 $18,333,333 38% $1,266,667 $6,416,667 35.00% $1,166,667 ($100,000) $0

#8 $666,667 $19,000,000 35% $233,333 $6,650,000 35.00% $233,333 $0 $0

SUM = $0

Column D in the chart above calculates the tax liability for a bracket, assuming that the rate for that bracket is 35% Column E then compares that hypothetical 35% tax liability with the actual liability for the bracket For brackets whose rates are less than 35%, column E therefore shows a savings—a benefit from paying the actual, lower rate rather than 35% However, in brackets #4 and #7, column

E is negative In these brackets, the marginal rates are greater than 35% These brackets are taking back the benefits of the lower-rate brackets If a taxpayer passes all the way through the 7th bracket,

as Boisjoly does, then all of the low-rate benefits are taken away The taxpayer whose taxable income is greater than $18.33M pays a flat 35%

3-11 Caraway Seed’s balance sheet is shown below:

TOTAL LIABILITIES $130,000

OWNERS' EQUITY

$19,000,000

$170,000

A Caraway’s total assets are the sum of its current (short-term) assets of $50,000 and its fixed (long-term) assets of $250,000: $300,000 Since this is what Caraway has, this is the amount for that it has received funding Caraway uses two types of funding: debt and equity It therefore must be true that its debt funding received plus its equity funding equals the total, $300,000

We are told that Caraway has $30,000 in current (short-term) debt, plus $100,000 in long-term debt It therefore has received a total of ($30,000  $100,000)  $130,000 in debt funding Since

it has $300,000 in assets, it must be that ($300,000  $130,000)  $170,000 in funding has come from equity (Once we know total assets and total liabilities, then, total equity is just a plug figure.)

B If we focus on current assets and liabilities, we can find net working capital, which is defined in equation 3-5 as:

net working capital = current assets  current liabilities

= $50,000  $30,000  $20,000

This is the amount of liquid assets that Caraway has, above and beyond what it needs to make payments over the next year Given that its current liabilities are $30,000, a cushion of $20,000 seems to imply that Caraway is very liquid

C Knowing that the firm’s $30,000 in current liabilities is comprised of $20,000 in accounts payable and $10,000 in notes payable does not affect working capital, which is based on total current liabilities and assets (See Figure 3.1, where working capital is defined graphically; current liabilities there include A/P and N/P.)

3-12 First, let’s categorize the accounts we were given:

Note that expenses and revenues go on the income statement, while assets, liabilities, and equity go

on the balance sheet

As shown on the next page, we will find retained earnings as the plug figure that will equate total assets with total liabilities and owners’ equity We use the following 2-step process:

less total liabilities = ($60,400) less common stock = ($45,000)

total equity = $60,250 retained earnings = $15,250